Tech start-ups fight Senate plan to change the way stock options are taxed

Reporting from Washington —  Senate Republicans have touted their tax bill as business-friendly, but technology start-ups — including Hyperloop One, Airbnb, Uber and Vimeo — are fuming over a provision that would make a major change to how stock options are taxed.

A key tool for start-ups to attract employees, stock options are currently taxed when they are cashed in. The Senate Republican tax bill, unveiled last week, would tax the options on the date they vest, meaning when the employee is allowed to begin cashing them in.

The difference is significant because employees often hold on to their options, hopefully until those options’ value rises with the growth of the company. Under the proposed change, employees could face large tax bills before they realize the income from cashing in the stock options to pay them.

The change would produce about $13.4 billion in additional federal tax revenue over the next decade, according to an analysis by the congressional Joint Committee on Taxation.

The House tax bill had a similar provision but removed it last week. Both bills also target stock options in another way.

They would eliminate a loophole that allows publicly traded companies to deduct the cost of stock options and other performance-based compensation to top executives.

The tax code now limits the deduction for pay and other compensation to each executive to $1 million. But the loophole allows companies to exceed that limit for performance-based pay.

The provision, in place since the 1990s, has been blamed for helping cause the sharp rise in executive compensation at publicly traded corporations. Eliminating it would produce about $10 billion in additional federal tax revenue over 10 years.

But the Senate’s proposed change in how stock options are taxed would specifically hit start-ups and has triggered an outpouring of opposition from technology companies and investors.

“This shift would have profound negative consequences for technology start-ups by, among other things, undermining their ability to compete with large incumbents,” said a letter from Engine, an advocacy group for technology start-ups, that was sent Tuesday to Senate Finance Committee Chairman Orrin G. Hatch (R-Utah).

“Start-ups do not have the ability to compete with larger firms based upon cash compensation,” said the letter, signed by about 540 tech companies, start-up executives and venture capitalists, most of them from California.

“A start-up’s ability to issue stock options levels the playing field by giving potential employees something unique: the ability to share in the company’s rewards as well as its risks and participate in the upside of a new and exciting venture,” the letter said.

The National Venture Capital Assn. said on Twitter that it was “working hard to remove the provision” from the Senate bill, which Hatch’s committee is considering this week.

Venture capitalist Fred Wilson said the stock option change “has profound implications for those who work in tech companies and equally profound implications for the competitiveness of the U.S. tech sector.”

“What this would mean is every month, when your equity compensation vests a little bit, you will owe taxes on it even though you can’t do anything with that equity compensation,” Wilson wrote in a blog post.

“You can’t spend it, you can’t save it, you can’t invest it. Because you don’t have it yet,” he said.

The dispute highlighted the difficulty of enacting major tax legislation as companies and interest groups often balk at changes aimed at them, such as the loss of tax breaks.

A similar stock-option tax change was in the original version of the House Republican tax bill. But the provision was removed last week when the House Ways and Means Committee approved an amendment with several changes offered by the panel’s chairman, Rep. Kevin Brady (R-Texas).

Hatch was set to release a revised version of the Senate Republican tax bill Tuesday.

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Twitter: @JimPuzzanghera

UPDATES:

1:50 p.m.: This article was updated with information about another executive compensation provision in the House and Senate tax bills.

This article was originally published at 9:25 a.m.